Blog | 28 Oct 2021

Why Canada needs a 10%-15% house price correction

Tony Stillo

Director of Economics, Canada

Rock-bottom mortgage rates and a pandemic-driven shift in buyer preferences have triggered a burst of housing demand that has run hard against a severe lack of supply, causing house prices to explode. Meanwhile, investors, house ‘flippers,’ and speculators, which according to the Bank of Canada account for over 20% of home purchases, have aggravated the severe demand-supply imbalance catapulting home prices nearly 40% higher than pre-pandemic levels.

Based on our Housing Affordability Index, sky-high prices have pushed the average Canadian home 14% above what median-income households can afford—a three-decade high. And it’s likely to worsen. Even with plateauing house prices in our baseline forecast, we expect rising mortgage rates will push house prices more than 20% above affordability for the typical Canadian household by the end of 2022.

Canada Housing Affordability

Past experience suggests housing can remain unaffordable for years, but eventually prices realign to household borrowing capacity. Toronto homes in 1990 cost a staggering 60% more than what average-income households could afford, and it took five years of falling interest rates, lower house prices, and rising incomes to make a typical Toronto home affordable for locals.

Now, with mortgage rates expected to rise from their historic lows, making housing affordable again will come from either much stronger growth in household income, which appears unlikely, or from lower prices. While we can’t ignore the risk that the price bubble could burst, we believe a crash is unlikely considering the government’s generous stimulus, abundant underlying demand, and a resumption of high immigration.

Instead, we think the economy is sufficiently well-positioned for the government to implement policies to engineer a managed correction to nominal house prices of around 10%-15%. We think a drop of this magnitude would realign prices with domestic fundamentals.

How to do it? During Canada’s recent federal election, all the major parties proposed surprisingly similar solutions. In our view some key initiatives in the Liberal’s housing plan could provide a quick boost to supply while also lowering price expectations:

The recent surge in house prices has put the dream of home ownership out of reach for many Canadians. To help those not already on the property ladder, action is needed. And fast.

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